Wednesday, August 29, 2007

I have been flagging India's growing importance to the international investment banks adn I've said that the decision of the big ones- Morgan Stanley, Merrill and Goldman Sachs- to go it alone or as the dominant partner reflects this.

Today's FT story on how important India is to Merrill Lynch underlines this. Two factors have been particularly important in making India important to the world majors: rising share issuance and M&A volumes.

India has for the first time become the biggest revenue contributor among Asia’s emerging economies for Merrill Lynch, highlighting the country’s increasing importance for global investment banks.

The trend was driven by a record flow of share offerings and large mergers and acquisitions in India this year, coupled with increasing principal investment by the bank, said Patricia McLaughlin, vice-chairman and managing director, investment banking and M&A at DSP Merrill Lynch. “India has become relevant to Merrill Lynch in revenue terms; not only regionally but globally,” Ms McLaughlin told the Financial Times.

.......Merrill Lynch did not provide figures for its Indian revenues but said they were larger than those for other markets in Asia excluding Japan and Australia.

This year's share issuance undewriting by the top 10 underwritersis $23. 3 bn to date, double that in the same period last year; and M&A volumes are $63.9 bn, again twice as last year. That would explain why Bear Stearns is planning to enter India soon.

Tuesday, August 28, 2007

I have repeatedly argued that the Indo-US strategic relationship, centring for the moment on the Indo-US nuclear deal, is intended mainly to counter China's growing influence in Asia. Strategic affairs expert K Subrahmanyam once again expatiates on this theme in an article in TOI today.

He argues, as US academic John Garver did in his book Protracted Contest (the authoritative work on Sino-Indian relations), that China has tried hard to keep India as a South Asian power by building Pakistan as a nuclear counterweight to India. That would mean India cannot really challenge China in the overall Asian sphere. The US and also major European powers want India to balance China in Asia; they now want India to break out of the India-Pakistan equation. That is part of the rationale for the nuclear deal.

The Chinese strategy of dominating Asia, which all other major powers view with concern, needs India to be kept tied down perpetually by a nuclear-armed Pakistan. The reason why liberating India from technology apartheid sponsored by the US is popular with Russia, France, UK, France and Japan is their desire to see a balance of power in Asia. In the 21st century it is not envisaged there will be wars among major powers. But there would be a constant balancing of power. China when fully developed can only be balanced by a billion-strong India if it develops itself. The other major powers of the world have a vital interest in this. Hence, the US nuclear agreement, India-specific IAEA safeguards and NSG waiver.

There is another angle to the deal which Bodhisatva Ganguli touches upon in the lead article in ET today. The nuclear deal is an enabling device for transfer of sensitive defence and advanced technologies to India. It is odd that this argument has not been made strongly enough in defence of the deal. Is it because it is not something that can be sold in the US in the face of strong opposition from proliferation hawks?

The forthcoming debate in parliament should illuminate these issues and also elicit a better understanding of the limitations to which India will be subject. The final decision on the Indo-US nuclear deal can then be taken by the political class as a whole in full knowledge of the trade-offs implied.

Friday, August 24, 2007

Central banks have been pumping funds into the markets in order to stabilise conditions. This troubles many people. Should central banks being bailing out failed institutions such as hedge funds that had taken foolish risks?

Well, no. Central banks may have to save banks because bank failure can pose systemic risk. The others can go to the wall. The difficulty is telling whether the problem at non-bank institutions is a liquidity problem or a solvency problem. It makes sense to make liquidity available to institutions at a time when market sources of liquidity dry up. If banks don't want to give money or to each other or to hedge funds because of panic conditions, central banks should.

But when prices are unstable, how on earth does the central bank determine whether institutions are insolvent or merely illiquid? Many of the institutions themselves don't know what their asset prices are- Bear Stearns kept telling investors in its hedge funds for a long time that it did not have a correct valuation.

So, there is a practical problem here. But there is broad acceptability now as to the conditions under which central banks should intervene. I dwell on this in my ET column, Central banks on a tightrope.

Many people just can't figure out the opposition to the Indo-US nuclear deal from across the political spectrum (and not just the left). The general impression among the intellegentsia is that the deal will propel India into the big league with US help and that we should just go for it.

I guess part of the problem is that US and Indian spokesmen have been putting a very different spins on the deal. India says there is no real bar on nuclear testing. A spokesman in the US promptly clarifies that if India should ever test, the deal is off. India claims that the deal will not encumber India's strategic weapons programme; US spokesmen assure Congress that the deal will cap and roll back India's nuclear capabilities and so on. In other words, the interpretation of the deal seems to be quite different in the two countries. While it is conceivable that some of it is meant for domestic lobbies, there is always the danger that the difference in interpretation is very real as well.

There's a timely story in Rediff.com that makes exactly this point and also warns that the nuclear deal could end up straining ties between India and the US instead of strengthening these.

"The governments of Manmohan Singh [Images] and George W Bush [Images] appear to be interpreting key provisions of the agreement very differently, which can only cause more headaches in future," said Michael Krepon and Alex Stolar of the Washington DC-based Stimson Centre.

One area of the potential dispute relates to the consequences of the resumption of nuclear testing by India, they said.

"The US public law is clear in this regard, but the India finds solace in pledges that the Bush administration has given to cushion the potential blow. One provision in the 123 Agreement pledges to provide India, one way or another, with an ample fuel bank to guard against disruption caused by nuclear testing," they said. However, the legislative intent of the Hyde Act "places clear constraints on fuel supplies", the scholars said.

The scholars said that using the nuclear deal to break the decades of mistrust between the two countries was an odd and unfortunate choice.

................If India decided to operationalise the deal, they said, the next stage would be to negotiate a safeguards agreement with the International Atomic Energy Agency.

"New Delhi has insisted that the agreement be India-specific, implying that if fuel is disrupted, safeguards can be dispensed with. In this regard, the 123 Agreement makes reference to India's right to corrective measures if fuel supplies are interrupted," they said.

"It also includes a clause that the US will assist India in its dealings with the IAEA," they said.

However, they contend that that it is very likely, that the IAEA will insist on safeguards in perpetuity, without conditions or reference to disrupted fuel supply.

"These and other implementation provisions are bound to cause greater difficulties in India and further fray relations with the US once it becomes evident that the 123 Agreement has papered over differences in interpretation, while disregarding congressional intent to reduce the deal's negative proliferation consequences," they said

These comments make a lot of sense. It would be unwise to paper over the implications of the deal for India. It is also important for both India and the US to realise that the potential for a strong relationship exists without the nuclear deal. The suggestion that if the deal is not clinched here and now, India and the US lose the chances of upgrading their relationship must be rejected in the most emphatic terms. The opposition to the deal from the Left does give all concerned a chance to reflect more carefully on the deal.

Thursday, August 16, 2007

The limits on ECBs imposed by the government have been generally welcomed. As Shankar Acharya points out in Business Standard, of the increase in the capital account surplus of $23 bn in 2006-07, ECBs accounted for $13 bn or nearly 60%. Unchecked ECB inflows have rendered exchange rate management that much more difficult.

It was another item in Acharya's article that took my breath away. The top 10 borrowers accounted for 30% of total approvals in 2006-07; around 20 corporates accounted for nearly half the borrowings. The two Reliance groups (of Mukesh and Anil Ambani) lead the field.

The world's central banks have been furiously pumping funds into the financial system to contain the panic in financial markets. (A notable exception is the Bank of England). Will they succeed?

I believe so. Markets tend to overreact. A sharp fall in asset prices will easily plunge highly leveraged institutions such as hedge funds into bankruptcy. But this is temporary in many cases and many funds can move back into solvency once overshooting of asset prices reverses. In the meantime, they need access to funds to tide over redemption calls. As long as central banks provide these, there should not be a problem. Besides, private buyers of distressed funds will also be available. In the case of commercial banks, central banks or the government may even effect a rescue.

The difficulty for central banks is providing liquidity but stopping well short of a bailout. This is necessary to avoid moral hazard in financial markets. Crises such as the one we are seeing today are the result of excesses. Those guilty of these must pay the price. Bailouts mean they will not pay the price. This may solve today's problem but it will create fresh problems down the road. Market players will take huge risks in the knowledge that central banks will save them. Many say that today's problems are precisely the result of Greenspan's willingness to cut interest rates to save falling markets.

In today's turbulent conditions, central banks may not be able to get the balance right. They may go overboard in calming markets. That is bad for financial market discipline. But it will certain prevent the crisis from snowballing. So, yes, central banks have it in them to stem the crisis but they may let it play out for a while to ensure that institutions that got carried away are weeded out.

I wrote in an earlier post that the central banks would manage to contain the crisis in the international financial markets and that it was unlikely the world economy would tip into a recession.

In the TOI last Sunday, Swaminathan Aiyar agreed with my contention that the health of the underlying economy was not necessarily determined by the health of the stock market. Nevertheless, he argued, the subprime mortgage problem in the US had the potential to create a worldwide economic crisis because it signalled a housing bubble burst in the US. This would drag down the US economy and housing bubbles elsewhere, including India, too would burst.

I am not convinced. A sharp deceleration in housing had already been factored into the IMF's forecast of a slowdown in the US economy, the subprime crisis does not change that. I don't see the US or global economic outlook changing because of the subprime crisis.

As for the prospect of a housing bubble burst in India, we have to remember that housing prices have been driven by very basic supply-demand imbalances. There is a supply shortage for various reasons and demand comes, not from speculators, but to a large extent from buyers of homes.

In the US, housing purchases are driven by borrowing against assets, including an existing house. So a decline in asset prices has a huge adverse impact on the housing market. In India, people are buying against future income - and rising incomes at that. Movements in asset prices such as those of stocks have little impact on this demand. If housing prices fall, that will translate into greater demand.

Again, since people are not consuming by borrowing against housing or other assets, the wealth effect on consumption will be very small. Yes, we could see a correction in housing prices but its economic impact will be negligible.

Thursday, August 09, 2007

Stock markets plunged worldwide last week (although some like India's have bounced back this week). Many were quick to pronounce that the underlying problems at financial institutions were grave enough to undermine economic growth.

I must beg to disagree. Stock market declines do not necessarily translate into setbacks for economies. Depends. Various factors are relevant: the soundness of banks, the policy response to a a stock market crash, companies dependence on stock market for finance for projects (pretty low in the US- nearly 98% of funds come from internal generation and the debt market and in some recent years, funding from stock market has been negative because of buybacks of stocks) and the wealth effect on consumption (also low in the US and lower still in markets such as India).

The killer is bank exposure to the stock market. Once banks fail, the economy is dragged down quickly. That's what happened in the Great Crash of 1929. It also happened in East Asia. The worst sufferer was Indonesia where the IMF mandated closure of bankrupt banks caused the a huge fall in GDP.

In India, the RBI's prudence has been a great life-saver. Stringent restrictions on bank exposure to stock markets (and also real estate) are one big reason why the vagaries of the stock market have not meant banks going under (except when banks, especially cooperative banks, sought to flout regulations).

In the present situation, many financial institutions have been hit by the problems in the subprime mortgages market but not commercial banks. Institutions have been trying to sell their holdings of securities linked to such mortgages and have otherwise taken huge hits. The liquidity problems at hedge funds and investment banks spells dog days for international financial markets. But commercial banks are relatively unsinged, so the US economy will not face a crisis. The world economy is not affected by US-specific factors and hence global economic growth will continue to be strong.

Monday, August 06, 2007

The government has been unable to amend the Banking Act to permit government shareholding to fall below 51% in public sector banks (PSBs)- the Left and the unions are dead set against it. But PSBs need fresh capital in order to grow. SBI management has been making desperate representations to government on this subject. It appears there is relief in sight.

Government shareholding in SBI is around 59%. The minimum government shareholding required under the SBI Act is 55%. That leaves room for raising around Rs 6000 crore of fresh equity. On top of it, ET reports, the government plans to infuse Rs 10,000 crore. I would have thought this would be unthinkable on account of the FRBM restrictions. But, ET reports some interesting calculations being done in government:

Assuming that the government infuses Rs 10,000 crore and if this is leveraged to build a portfolio by an additional Rs 1,00,000 crore, the resulting dividends and the tax on increased profits will make up for the government’s capital costs. Even at a 1% return on assets, the government could recover a significant amount from the bank, sources said.

And the move could set a precedent. The government’s stake in more than a dozen state-run banks is close to the minimum 51%. It is understood that it is open to infuse funds into these banks, should they require more capital.

As if this weren't enough, along comes a suggestion from C Rangarajan, chairman of the PM's Council of Economic Advisors. Rangarajan has mooted the idea of quasi-government entities such as LIC putting capital into banks.

Quasi-Government entities like LIC could be roped in to fund additional capital needs of public sector banks as they move to meet Basel II standards, Chairman of the Economic Advisory Council to the Prime Minister C Rangarajan said.

In case of Government's inability to bring in additional capital or reducing its share from 51 per cent, Rangarajan suggested funding from quasi-government entities such as the Life Insurance Corporation through an amendment in the statute.

"Government will have to bring in additional capital or reduce its share in public sector banks from 51 per cent through appropriate statutory changes," Rangarajan said, adding adoption of Basel II norms will enhance the required capital.

Well, well. I must say it is nice to see new ideas on the subject of capital for PSBs just when we thought they were up a blind alley.

The Indian and US governments have each their own spin on the Indo-US deal.The question is: who is closer to the truth? Is the Indian government right in claiming that the strategic weapons program is unencumbered? Are the pronouncements of US spokesmen meant only to preempt opposition from the non-proliferation hawks in the US? Hard to say, really.

M J Akbar is among the sceptical voices in the media. In his column in Asian Age, he writes:

The 123 Agreement was announced on Friday 27 July. On 2 August, just six days later, Nicholas Burns, undersecretary of state and chief American negotiator was asked by a journalist, Robert McMahon, in a recorded interview, "Some say that under the deal, if India holds a nuclear weapons test, the US would delay its own nuclear fuel supplies to India but the US would help India find other sources of fuel, which violates the spirit of the Hyde Act. What do you say to those concerns?"

Burns replied: "That’s absolutely false. I negotiated the agreement and we preserved intact the responsibility of the President (of the United States) under the Atomic Energy Act of 1954 that if India or any other country conducts a nuclear test, the President — he or she at that time in the future — will have the right to ask for the return of the nuclear fuel or nuclear technologies that have been transferred by American firms. We’re releasing the agreement on our website on Friday afternoon (3 August 2007) and people will see that when they cite the text."

The answer could not be more categorical: "absolutely false". That is the American position, and it is being enunciated for the record, without any ambiguity. The message is clear, and it is loud. America will demand fuel and technology back, and probably not return the still-uncounted billions of dollars we paid for it either

I haven't gone through the text myself but I read in newspaper reports that the 123 agreement does provide for the US president to take into account the circumstances surrounding a particular test. It is also said to mention compensation to India for return of US materials and fuel. So, I am not sure that Akbar's doubts on this score are justified.

Another discordant voice is that of former PM VP Singh. Asian Age reports:

Mr Singh said the draft agreement to operationalise the deal does not grant India reprocessing, enrichment and heavy water technologies and allows the US to terminate the pact with a year’s notice. He said the deal does not grant India the status of a nuclear weapons state and binds it to the national laws of the US, such as the Hyde Act. "It is ironical that a similar agreement with China grants supremacy to international laws while we are bound by the Hyde Act," Mr Singh said.

He demanded that Prime Minister Manmohan Singh explain to the nation the agreement in detail and seek Parliament’s approval before signing it. "Friendship with the US is okay, but we should not accept slavery," Mr Singh said, adding that he will go to the states and meet people to make them aware of the nuclear deal that India is about to sign.

The UPA government has thus far taken the position that it is under no obligation to consult parliament in the matter of signing the deal with the US. That may be the constitutional position but PM Manmohan Singh would be wise to have a thorough discussion in parliament or in one of the parliamentary committees.

Wednesday, August 01, 2007

Yes, Murdoch will be the new owner of Wall Street Journal. The Bancroft family has decided to back his offer. FT reports:

Rupert Murdoch on Wednesday clinched victory in his battle to acquire Dow Jones after securing support from enough Bancroft family members to secure majority backing for his $5bn cash offer for the owner of The Wall Street Journal.

The breakthrough came after nearly four months of often torturous negotiations between the media mogul and the fractious clan of heirs to a family which has controlled the leading US financial newspaper for more than a century.

Will this mean that New York Times will also be up for grabs? No says, FT's Lex column. Part of the problem with the Bancroft holdings was that it is fragmented. At NYT, Arthur Sulzberger calls all the shots.

I had a post on sovereign wealth funds yesterday. Today Swaminathan Aiyar weighs in with an article in ET. Aiyar seems to think that large purchases of equity by emerging market sovereign funds could raise the spectre of a takeover of western firms by Asian governments.

Well, as long as the acquisitions are small and sovereign funds are passive investors, western governments will keep quiet. I doubt that foreign governments will be mute spectators if the funds want to run companies. Sovereign funds will be expected to play the role that FIIs do in India- voting with their purchases and sales and not attempting in any way to directly influence management.

Moreover, large acquisitions by sovereign funds will fuel demands for a reciprocal opening up of markets in developing countries and this in itself will put the brakes on such acquisitions. Lastly, the performance of the funds is also an issue. Can governments manage large equity positions to their benefit? Remains to be seen.